If you read this blog with any kind of regularity, you know that we feel pretty strongly about the importance of financial forecasting. Budgets are valuable assets, a direct line of sight into the health of your business — as long as you take the time to look at and update your forecasts weekly or monthly. And that includes your balance sheet forecasts.
Granted, not many CFOs take the time to forecast their balance sheets because it’s notoriously difficult to do so in a spreadsheet. This is a mistake because it can lead to unpleasant surprises (such as discovering the company won’t have enough cash on hand to meet payroll, forcing the company to apply for a loan in a hurry).
Don’t count on your P&L to do the work of your balance sheet, because it’s simply not designed to track deferred revenue or expenses. Here’s why: Let’s assume your company has earned $1 million in revenue for a month, and has incurred $800K in expenses. Your P&L would indicate that you have $200K in cash on hand when in fact, that may not be the case at all. Your sales team may have offered unusually long payment terms for a client, meaning you won’t realize a chunk of revenue until some point in the future. And although you’ve incurred $800K in expenses, your own payment terms may mean you don’t need to pay an invoice immediately or all at once.
Things to consider when forecasting your balance sheet:
- Deferred revenue. If you sell products or services that prevent you from recognizing all of your revenue immediately, it’s essential that you look at your deferred revenue on a monthly basis to ensure it’s not too high. Deferred revenue is also a critical component to a company’s valuation, and is of keen interest to investors. By forecasting your balance sheet, you can identify when your deferred revenue is too high and take action to course correct, such as restricting payment terms offered by your sales team.
- Accounts receivables. Just as deferred revenue must be taken into account, so must your liabilities. The expenses you incurred during the month of June may come to $50K, but you may not be required to pay that full amount right away. Likewise, you may be required to make payments on expenses you incurred in January.
- Accuracy. Many wonder if it’s even possible to forecast a balance sheet accurately. As we’ve explained in a previous post, the answer depends on the accuracy of the income statement forecast. If you overestimate your sales in a given budget period, then your balance sheet forecast will be off as well. One way to increase the accuracy of your balance sheet forecasts is to limit how far ahead you look. Changes can occur monthly, which will affect the accuracy.If you rework your financial forecast right after month-end close, you can quickly and effectively analyze your actual results against the budget data. This allows you to to make decisions that will impact the organization’s future performance much quicker.
Best Practices for Forecasting Balance Sheets
|Find an Automated Budgeting Tool||It’s difficult to forecast a balance sheet using a spreadsheet, as there are too many moving parts. We recommend using a budgeting tool that allows you to forecast your entire chart of accounts and gain insight into much more useful data than just the revenue and expense forecast. An automated tool will make it easier to reforecast frequently.|
|Don’t Forecast Too Far Ahead||While we believe in forecasting your balance sheet, we don’t recommend forecasting too far out. To begin, it’s difficult, especially if you don’t have an automated tool. Second, each month will bring new changes that will decrease the accuracy of your forecasts.|
|Do Sensitivity Analysis||Determine the best way to book your actuals. For instance, experiment with sales and expenses within your P&L to see how they flow through to the balance sheet. This exercise will help the management team make better and more accurate decisions.|
For more information on forecasting, check out our free on-demand webinar on The Power of Building a Budget Synchronized with your Financial Statements.
Centage Corporation’s Planning Maestro is a cloud-native planning & analytics platform that delivers year-round financial intelligence. With Planning Maestro, Centage offers the sophisticated features needed by small and mid-market organizations to integrate budgeting, forecasting, and deep data analysis within one easy-to-use, scalable SaaS solution. For more information on how to modernize your office of finance with intelligent planning, view our product demonstration video, or call 800-366-5111.